Tokyo Reversing Slide in Office Rentals: Real Estate

March 5 (Bloomberg) -- Tokyo’s office market is showing
signs of recovery after a two-decade decline, prompting
companies such as Apple Inc. and Morgan Stanley to relocate
before rents rise and vacancies fall.

Real estate broker Jones Lang LaSalle Inc. and Barclays Plc
are forecasting leasing costs for prime office space will climb
this year and next. The vacancy rate for grade-A buildings in
the city’s major business districts fell for a second quarter to
8.8 percent as of December from a record 10.3 percent in the
three months to June, according to broker CBRE Group Inc.

“We are now seeing some very early signs of a return in
confidence to the market,” said Neil Hitchen, regional director
at Jones Lang LaSalle in Tokyo. Tenants “are renegotiating
terms early to try to take advantage of the tenant-favorable
market conditions and get in good shape for the next few
years,” he said.

The rebound may signal the end of a 21-year slide that cut
rents for all categories of offices in the city’s five central
wards by 63 percent, according to Miki Shoji Co., a Tokyo-based
broker. Japan has been struggling with deflation that has caused
companies and households to put off spending since the late
1990s, after asset prices collapsed.

Landlords are now seeking rent increases and investors are
considering acquisitions as Prime Minister Shinzo Abe pursues
fiscal and monetary stimulus to pull Japan out of its third
recession in five years. Contracted rents for prime office space
in the central wards rose 13 percent to 23,969 yen ($257) per
tsubo in the fourth quarter from the previous three months,
according to Sanko Estate Co., a Tokyo-based broker. Prime
refers to the most stable high-income producing properties.

Rising Expectations

“There is an increase in expectations that real estate
investment will become more active, helped by monetary easing
since Abe took over the government,” said Masashi Hirano,
president and chief executive officer of Tokio Marine Property
Investment Management Inc., a unit of Japan’s second-biggest
casualty insurer. Tokio Marine Property plans to raise a fund to
invest in Tokyo’s office buildings for the first time since 2008,
Hirano said.

Tokyo isn’t alone. Office vacancies in Osaka, the second-biggest city, are declining after reaching a record high of 12.4
percent in March 2011.

While vacancy rates are improving, leasing costs remain
under pressure. Rents for all classes of office space in the
central wards were at an all-time low of 16,554 yen per tsubo in
January, compared with the peak of 44,193 yen per tsubo in 1991,
according to Miki Shoji. A tsubo, the standard measure of
property in Japan, is 3.3 square meters or 35.5 square feet.

False Start

The five central wards, the heart of Tokyo’s shopping,
entertainment and business districts, are Chiyoda, Chuo, Minato,
Shinjuku and Shibuya.

Investors and landlords remain cautious because turnarounds
have fizzled in the past. Tokyo’s office vacancy rate fell for
two straight quarters through September 2011 before 176,000
tsubo of new prime space flooded the market last year, according
to DTZ.

Office rents in the central wards rose in the three years
to 2008, before the global financial crisis, as increasing
demand pushed vacancies to around 4 percent in 2005, leading
landlords to raise rents, according to Miki Shoji.

Even after years of decline, rents for prime offices in
Marunouchi and Otemachi, both in Chiyoda ward, were the third-most expensive after Hong Kong’s Central district and the West
End in London as of the third quarter last year, according to
the latest survey by CBRE. Office space in Tokyo costs $197.27
per square foot on an annual basis, while in Hong Kong it costs
$246.30 per square foot.

Mitsubishi Estate

“We doubt that rents will go shooting up across the market,
or even in local CBD areas, but individual buildings can have
pricing strength if they are well occupied,” said James Fink,
senior managing director at broker Colliers International in
Tokyo. “It’s going to take a while for the overall market to
recover because it’s been so beaten down.”

In 2012, 47 percent of 638 company tenants based in greater
Tokyo and surveyed by CBRE were considering moving offices,
compared with 37 percent in 2010.

Jones Lang LaSalle sees an annual average increase of about
5 percent in rents this year and next, while Barclays sees a
cumulative gain of 20 percent through the end of 2014.

A rebound would be welcome news for the biggest landlords
in the wards, including Mitsubishi Estate Co., Mitsui Fudosan Co.
and Sumitomo Realty & Development Co.

Shares of Mitsubishi Estate, which has gained 83 percent in
the past six months, fell 2.1 percent to 2,484 yen in Tokyo
today, while Mitsui Fudosan declined 2.1 percent to 2,439 yen,
bringing its gain in the past half year to 67 percent.

Planning Ahead

Mitsubishi Estate and Mitsui Fudosan, Japan’s biggest
developers, are asking for higher rents, according to Masahiro
Mochizuki, an analyst at Credit Suisse Group AG, who rates the
two builders outperform.

Mitsubishi Estate won’t lower rents despite the recent
increase in the vacancy rate in Marunouchi because the developer
expects more companies to fill in the space as they seek to
relocate to the area, Keiji Takano, a spokesman, said at the
earnings press conference on Feb. 4.

“We have shifted our strategy not to lower rents in
Marunouchi,” he said.

Companies are planning ahead. Apple will move its Tokyo
headquarters to the 54-story Roppongi Hills complex, in Minato
ward, from Shinjuku ward as early as April, two people familiar
with the iPhone maker’s plan told Bloomberg News in January. The
$2.2 billion development owned by Mori Building Co. is home to
Goldman Sachs Group Inc. and Barclays.

Morgan Stanley

Morgan Stanley is moving back to Otemachi, an area
neighboring the Imperial Palace. It signed an office lease with
Mitsubishi Estate to take space in the 34-story Otemachi
Financial City South Tower amid “attractive conditions for
tenants of prime commercial locations,” the bank said in
December. It moved to Ebisu, a mainly residential neighborhood
of boutiques and restaurants in Shibuya ward, from Otemachi in
1996.

“The market is starting to find the bottom,” Colliers’s
Fink said. “Most buildings that had very high vacancy when the
crisis began in 2008 and 2009 reduced rents and leased up most
vacancy. Because they are full, the landlords are able to ask
for higher rent from new tenants and for lease renewals.”

The tenant profile of Marunouchi also has diversified over
the past decade, contributing to stability in demand, said Fred
Takahashi, who represents tenants at CBRE.

Tenant Profile

In 2000, manufacturing companies such as Mitsubishi Heavy
Industries Ltd., which makes trains, ships and planes, and
Fujitsu Ltd., Japan’s biggest provider of computer services,
accounted for 43 percent of Marunouchi’s tenants, according to
Mitsubishi Estate. That percentage fell by about half over the
past decade, while the ratio of financial and service providers,
including accounting and law firms, almost doubled, according to
the developer, the biggest landlord in the district.

The Marunouchi area is home to Japan’s three-largest
lenders: Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui
Financial Group Inc. and Mizuho Financial Group Inc.

The area is undergoing rejuvenation after the completion in
October of a 50 billion yen renovation of Tokyo Station.

Bridgestone Corp., the world’s largest tire maker, said it
plans to move in January 2014 into a new building near Tokyo
Station, from the 61-year-old building it currently occupies
southeast of the station.

Salesforce.com Inc., a San Francisco-based maker of online
customer-management software, plans to move to JP Tower in
Marunouchi from Roppongi Hills in the middle of this year. Among
others that moved into the neighborhood are Digital Arts Inc.,
which develops games for the iPhone, and GungHo Online
Entertainment Inc., an Internet game developer.

Limited Supply

Limited supply will put a floor under rents, said DTZ. New
supply of offices in Tokyo will be about 40 percent of last
year’s level, when the most space since 2003 was added,
according to DTZ, which forecasts rents to increase by 7 percent
this year.

“As we see signs of a recovery for vacancy rates, we
should be able to see rental growth in the latter half of the
year,” said Singapore-based Hidetoshi Ono, the head of Japan
Core Fund at AXA Real Estate Investment Managers. AXA Real
Estate’s Tokyo Office Property Fund is in the process of buying
several office buildings in the capital in the first quarter as
it bets office rents and prices will rise, Ono said, declining
to elaborate.

The capitalization rate, a measure of investment yield, for
office buildings in Tokyo declined for two straight months to
5.3 percent in January from 5.5 percent in November, the highest
since Real Capital Analytics Inc. started compiling the data in
2009. A drop in the cap rate, which is a property’s net income
divided by the purchase price, usually signals an increase in
real estate prices.

Target Japan

Hartford, Connecticut-based Cornerstone Real Estate
Advisers LLC, which managed $38.9 billion as of Dec. 31, opened
a Tokyo office in September and is considering raising a fund to
invest in properties in the city, including office buildings and
real estate debt.

“We are setting up our investment platform in Asia and our
first target is Japan,” said Kelly Hayes, a Tokyo-based
director at Cornerstone, a subsidiary of Massachusetts Mutual
Life Insurance Co. of Springfield, Massachusetts. “We are
seeing bottoming out of rents. That started before Abenomics,
but Abenomics certainly will help propel that.”

Billionaire Akira Mori, owner of office buildings in
central Tokyo, is among those betting on a turnaround. Mori said
in November he plans to invest in property in the city for the
first time since he declared the end of the real estate boom in
2008.

“Japan’s economic recovery, a peak-out in new office
supply and the take up of new office space that we are seeing
for the first half of this year will enable landlords to boost
rents,” said Takashi Hashimoto, an analyst at Barclays in Tokyo.